Test 1 Preparation

Chapter 16 – Presentation of financial statements.

Components of financial statements

• financial statements set (paragraph 10 of AASB 101/IAS 1) comprising: (5)

a statement of financial position (BS)

a statement of profit or loss (PL) and other comprehensive income (OCI)

a statement of changes in equity (SOCE) for the period

a statement of cash flows (CF) for the period

notes, summary of accounting policies and other explanatory information

– comparative information in respect of the abovementioned period (paragraphs 38 and 38A)

General features of financial statements

• AASB 101/IAS 1: 8 general principles that need to be applied in the presentation of financial
statements to ensure that the financial statements of an entity are a faithful presentation of its
financial position, financial performance and cash flows in accordance with the Conceptual
Framework.

1. Fair presentation and compliance with standards:

• Paragraph 17 of AASB 101/IAS 1: elaborates on the meaning of ‘fair presentation’ as

including:

select and apply accounting policies in accordance with AASB 108/IAS 8

presenting relevant, reliable, comparable and understandable information

Statement of financial position BS

• The statement of financial position serves this purpose (fair presentation and compliance with the
standards) because

- summarises the elements into an entity’s A, L and E.

- evaluates an entity’s capital structure and analyses its liquidity, solvency and financial
flexibility.
- provides basis for calculating rates of return.

• Limitations of the statement of financial position:

- financial engineering leads to off-balance-sheet rights and obligations

- the aggregation of amounts measured inconsistently.
Statement of profit or loss and other comprehensive income P&L OCI

• Information required to be presented in the statement of profit or loss and other comprehensive
income:

Limitations of P&L OCI:

- deliberate earnings management / making biased judgements relating to the measurement

of items of income or expense for projecting an image of earnings growth, e.g., impairment
loss, or recognising costs as assets (prepaid) instead of expenses.

Information required to be presented in the PL OCI/ notes:

97 of AASB 101/IAS 1 requires: separate disclosure of the nature and amount of material items of
income and expense

For users to predict the future sustainability of the reported profit

Statement of changes in equity SOCE:

- reconcile the opening and closing amounts of each component of equity for the period.
- to report transactions with owners: new shares and the payment of dividends, and the
effects of any
- retrospective adjustments to beginning-of-period components of equity.

Notes

 integral part of the financial statements.

- to enhance the understandability of BS, PL OCI, CF and SOCE
- As far as practicable, each item in these statements is cross-referenced to any related
information in the notes (AASB 101/IAS 1 paragraph 113).
Chapter 18 Accounting policies

• AASB 108/IAS 8 defines accounting policies as:

‘the specific principles, bases, conventions, rules and practices applied by an entity in preparing and
presenting financial statements’.

• Disclosure of accounting policies: the note must

- state whether the statements are prepared in accordance with accounting standards and
interpretations.
- disclose the measurement basis or bases used in preparing the financial statements.
- provide a description of accounting policies.
- disclose those judgements.
- disclose information about the assumptions made concerning the future

• Accounting policies (AASB 108) example:

revenue recognition (When to “record” in the financial statements, expense recognition,

measurement basis (historical costs, fair value, present value)

• Estimates/judgements, assumptions (future uncertainties example: current litigation) made

• AASB 101 “must disclose significant accounting policies

• Compliance with AASB (Australian Accounting Standards Board) is also compliance with IFRS
(International Financial Reporting Standards) Global set of accounting standards. They are law. Any
assumptions and judgements that you are making also needs to be noted.

Changes in accounting estimates

• As stated in paragraph 33 of AASB 108/IAS 8:

‘the use of reasonable estimates is an essential part of the preparation of financial statements and
does not undermine their reliability’.

• In business, many estimates are made of accounting information because of the uncertainty of
future events.

This topic is about a change in Accounting estimates: see page 686/687 – the typical example would
be depreciation): estimate useful life of an asset, 5, 10, 20 years.

- Is made “prospectively”: from now on into the future. Include the change in the P & L
statement in the reporting period of the change.

change in accounting estimatesimprove the reliability of the financial reports.

Errors

• Prior period errors:

Paragraphs 41–49 of AASB 108/IAS 8 consider the treatment of errors made by an entity in the
preparation of its financial statements.
Impracticability in respect of retrospect adjustments for accounting policy changes or correction of
errors

• The terms ‘retrospective application’ and ‘retrospective restatement’ are defined in paragraph 5 of
AASB 108/IAS 8:

Retrospective restatement is correcting the recognition, measurement and disclosure of amounts of

elements of financial statements as if a prior period error had never occurred.

• Relevant section for errors in text book – 687-691

• Definitions are on the top of page 691

AASB 108 is divided up into three sections

1. Disclosure of accounting policies

2. Changes in accounting estimates

3. Accounting for prior period errors

Events occurring after the end of the reporting date

• The financial statements are prepared on the basis of conditions which exist at the end of the
reporting period.

• But there can be events after that date which identify or clarify such conditions.

• Paragraph 3 of AASB 110/IAS 10 defines events after the reporting period as: those events,
favourable and unfavourable, that occur between the end of the reporting period and the date when
the financial statements are authorised for issue.’ (date of report being issued)

• Adjusting events after the end of the reporting period:

- Events occurring between the end of the reporting period and the date the financial
statements are authorised for issue and that provide evidence of conditions that existed at
the end of the reporting period.
- Referred to as adjusting events.
- The financial effect of adjusting events to be reflected in the financial statements (SOCE)
prepared at the end of the reporting period.

• Non-adjusting events after the end of the reporting period: Events that are indicative of conditions
that arose after the end of the reporting period.

- Must be disclosed by way of note to the financial statements.

- If the financial effect of the event cannot be reliably estimated, the note should disclose this
fact.
 - If an event after the reporting date leads management to determine that the entity will
liquidate or cease trading, intentionally or otherwise, paragraph 14 of AASB 110/IAS 10
prohibits the entity from preparing its accounts on a going concern basis.
- Accordingly, the financial statements would need to be redrafted using liquidation values for
the entity’s net assets as these values would be deemed more relevant to the circumstances
of the entity and the needs of the user

Summary

• How accounting policies and changes to accounting policies are disclosed in general purpose
financial statements. (annual report)

• How changes in accounting estimates are accounted for and disclosed in general purpose financial
statements.

• How prior period errors arise, and how they are accounted for and disclosed in general purpose
financial statements.

• The requirements when it is impracticable to make retrospective adjustments for changes in

accounting policies or correction of errors.

• The concept of materiality and how material items are identified.

• The difference between types of events occurring after the end of the reporting period and how
they are to be treated in the financial statements.

• Calculations not required for this topic.

• Disclosure topics
Activity 18

Materiality and events after the reporting period

The following information has been made available to you to assist in the preparation of
the financial statements of Alys Ltd for the year ended 30 June 2022.

(a) The company has been involved in a dispute with a government environment agency
relating to the release of noxious gases from its manufacturing plant in early June 2022.
An expert investigation was conducted to determine if the company was at fault. The
draft financial report already discloses contingent liability in the notes detailing the
investigation and estimating the potential damages at $1.25 million. The investigator’s
report, released on 1 August 2022, found Alys Ltd to be responsible for the release and
damages amounting to $1 500 000 were payable by the company.

Error prior to the reporting date

Early June 2022

Dr Damages expenses $1 250 000

Cr Provision for damages $1 250 000

Treatment;

30 June 2022

Dr Damages Expenses $250 000

Dr Provision for Damages $1 250 000

Cr Damages Payable $1 500 000

This is an adjusting event as the event exist in early June 2022, before the reporting date, which is
30 June 2022. Furthermore, the potential damage is material as it amounts to $ 1 500 000, this will
have an adverse impact on the profit and hence an explanatory note is required.

Note: In early June 2022, the estimated value of damage was $1 250 000. However, in 1 August
2022, the damage was concluded to be the company fault and amounted to $1 500 000. Hence, the
damage expenses for the reporting period 2022 will be adjusted and increase by the $250 000, from
the initial estimation of $1 250 000 to $1 500 000.

(b) On 9 July 2022, the sales manager raised credit notes worth $30 000 relating to sales of
faulty goods in the last 2 weeks of June 2022

This is an adjusting entry as the event exist in the last two weeks of June 2022, before the reporting
date, which is 30 June 2022. Furthermore, the sales of the faulty good is material as it amounts to
$30 000, this will have an adverse impact on the profit and hence an explanatory note is required.

Note: In the last two weeks of June 2022, the sales of faulty good amounted to $30 000 has taken
place. Hence, the credit note of $30 000 will be issued and the sales return will be increased by $30
000 while the trade receivable would be reduced by $30 000.
(c) On 25 September 2022, the company received notification that a customer owing $130
000 had gone into liquidation. The liquidator advised that unsecured creditors are likely to
receive a distribution of only 20c in the dollar. The liquidation was caused by a flood in
July 2022 which destroyed the customer’s operating plant and warehouse. The damage
was not covered by insurance.

Receive 20% - $26 000

Loss on receivable 80%- $104 000

This is not an adjusting entry as the event occurs after the reporting date of 30 June 2022, the
customer owing $130 000 is found bankrupt on 25 September 2022, and resulting in only 20% of the
amount, $26 000 could be received. Furthermore, this event is material as it amounts to a loss of
$104 000 and will have an adverse impact on the profit and hence an explanatory note is required.

Note: the event of 80% loss on receivable occurred on 25 September 2022 due to the flood in July
2022 destroying customer’s operating plant and warehouse and resulting in liquidation.

Chapter 17 Purpose of a statement of cash flows

• The overall purpose of a statement of cash flows is to present changes in cash and cash equivalents
of an entity during the period, classified by operating, investing and financing activities. OIF

• The statement of cash flows can assist investors, creditors and other users of financial statements
to evaluate:

- the entity’s ability to generate cash and cash equivalents

- the entity’s ability to affect the amount, timing and certainty of generating future cash flows
- the entity’s need to utilise cash and cash equivalents.
The classification of cash flows as arising from operating activities, investment activities and finance
activities is useful in analysing the movement in cash and cash equivalents during the period.

• When used in conjunction with other financial statements, information about cash flows assists
users of financial statements to:

– predict future cash flows

– evaluate an entity’s financial structure (including liquidity) and its ability to meet its obligations and
to pay dividends

– understand the reasons for the difference between profit or loss for a period and the net cash flow
from operating activities

– compare the operating performance of different entities.

Classifying cash flow activities

• Paragraph 6 of AASB 107/IAS 7 defines cash flow activities as:

– Operating activities: are the principal revenue-producing activities and not investing or financing
activities.

– Investing activities: are the acquisition and disposal of long-term assets and other investments not
included in cash equivalents.

– Financing activities: are activities that result in changes in the size and composition of the
contributed equity and borrowings of the entity.

Format of the statement of cash flows

• Reporting cash flows from operating activities:

– Paragraph 18 of AASB 107/IAS 7 provides that cash flows from operating activities may be reported
using one of two methods:

- direct method: whereby major classes of gross cash receipts and gross cash payments are
disclosed.
- indirect method: whereby profit or loss is adjusted for the effects of transactions of a non-
cash nature, any deferrals or accruals of past or future operating cash receipts or payments,
and items of income or expense associated with investing or financing cash flows.

• Reporting cash flows from investing and financing activities:

– For example, if an entity borrows money to repay another long-term loan, it must report a gross
financing cash inflow for the amount borrowed and gross financing cash outflow for the repayment
of the original loan.

• Reporting cash flows on a net basis:

– Paragraph 22 of AASB 107/IAS 7 allows the following cash flows to be reported on a net basis:

a) cash receipts and payments on behalf of customers when the cash flows reflect the activities of
the customer rather than those of the entity; and

b) cash receipts and payments for items in which the turnover is quick, the amounts are large, and
the maturities are short.
Preparing a statement of cash flows

• Unlike the statement of financial position and statement of profit or loss and other comprehensive
income, the statement of cash flows is not prepared from an entity’s

general ledger trial balance.

• Preparation requires information to be compiled concerning the cash inflows and

cash outflows of the relevant entity over the period covered by the statement.

• Cash flows from operating activities:

– The direct method follows the process below.

• determining cash receipts from customers

• determining interest received

• determining cash paid to suppliers and employees

• determining interest paid

• determining income tax paid

• summarising cash flows from operating activities.

• Cash flows from investing activities:

– Determining cash flows from investing activities requires identifying cash

inflows and outflows relating to the acquisition and disposal of long-term

assets and other investments not included in cash equivalents.

– The plant reported in the statement of financial position is net of

accumulated depreciation.

– The net increase in plant reflects the recording of acquisitions, disposals and

depreciation.

• Cash flows from financing activities:

– Determining cash flows from financing activities requires identification of

cash flows that resulted in changes in the size and composition of

contributed equity and borrowings.

Other disclosures

• AASB 107/IAS 7 prescribes additional disclosures in the notes to the financial

statements, including:

– information about the components of cash and cash equivalents

– changes in ownership interests of subsidiaries and other businesses

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– non-cash investing and financing transactions.

• Components of cash and cash equivalents:

– The components of cash and cash equivalents must be disclosed and

reconciled to amounts reported in the statement of financial position.

– The reconciliation provides better transparency of how items are reported in

the financial statements.

• Components of cash and cash equivalents:

– Paragraph 48 of AASB 107/IAS 7 requires disclosure of the amount of

significant cash and cash-equivalent balances held that are not available for

general use.

• Changes in ownership interests of subsidiaries and other businesses:

– Financial statement users need to be aware of the effects of changes in

ownership and control in order to understand the change in financial

position of the consolidated group.

– When an entity obtains control of a subsidiary or other business, any cash

and cash equivalents acquired are deducted from the cash consideration

paid in determining the cash flow effects of obtaining control.

• Non-cash transactions:

– Non-cash investing and financing transactions need to be understood in

order to comprehend the change in financial position of an entity.

– Examples include:

• acquisition of assets by means of a lease or by assuming other

liabilities

• acquisition of assets or an entity by means of an equity issue

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• Non-cash transactions:

– Examples include:

• conversion of debt to equity

• conversion of preference shares to ordinary shares

• refinancing of long-term debt

• payment of dividends through a dividend reinvestment scheme.

• Non-cash transactions:

– In regard to non-cash transactions, paragraph 43 of AASB 107/IAS 7 states:

• ‘Investing and financing transactions that do not require the use of

cash or cash equivalents shall be excluded from a statement of cash

flows’.

• Non-cash transactions:

– The other major non-cash transaction is the purchase of plant, equipment

and leasehold improvements for which the company has not yet paid.

• Disclosures that are encouraged but not required:

– Paragraph 50 of AASB 107/IAS 7 encourages, but does not require, additional

information that may be relevant to users in understanding the financial

position and liquidity of an entity.

Summary

• The statement of cash flows is particularly useful to investors, lenders and others

when evaluating an entity’s ability to generate cash and cash equivalents, and to

meet its obligations and pay dividends.

• The statement of cash flows is required to report cash flows classified into operating,

investing and financing activities, as well as the net movement in cash and cash

equivalents during the period.

• Net cash flows from operating activities may be presented using either the direct or

the indirect method.

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• AASB 107/IAS 7 requires additional information to be presented elsewhere in the

financial statements concerning investing and financing activities that do not involve

cash flows and are therefore excluded from a statement of cash flows.

• AASB 107/IAS 7 requires additional disclosures relating to the cash flow effects of

obtaining or losing control of subsidiaries and other businesses.